(Bloomberg) -- Less than two weeks after Illinois lawmakers broke through decades of gridlock and passed a bill to bolster the worst-funded U.S. state pension system, taxpayers are already seeing the benefits.
The state sold $350 million of taxable general-obligation bonds yesterday to pay for work on roads, bridges, schools and public transportation. Debt due in December 2038 priced to yield 5.65 percent, data compiled by Bloomberg show. The 1.84 percentage points of extra yield above benchmark Treasuries was almost a third less than in a comparable sale in April, Bloomberg data show.
The 29 percent reduction from eight months ago saves more than $20 million over the life of the securities, according to Abdon Pallasch, assistant budget director for Illinois, which has the lowest credit grade among states. Standard & Poors signaled this week that the accord on retirement costs could trigger a ratings increase.
The market recognizes that this is a clear improvement and that the credit risk of the state is diminished as a result of this pension action, said Chris Mier, chief municipal strategist at Loop Capital Markets in Chicago.
Illinoiss role model for regaining favor in the $3.7 trillion municipal market may be California, with an S&P credit grade one step higher. The Golden State had its bond ranking raised by S&P and Fitch Ratings this year after voters approved tax increases that produced a projected budget surplus. Californias bonds rallied this year to the most expensive levels since 2008.
Underfunded public pensions have prompted changes in states from California to New York. Since the recession ended in 2009, three-quarters of states have curbed costs through steps such as requiring public employees to pay more into pension funds or cutting benefits for new workers, according to the National Association of State Retirement Administrators.
In Illinois, the proposal passed last week would limit annual cost-of-living allowances and raise the retirement age for some workers. The plan projects $160 billion of savings over the next 30 years.
The agreement extended a two-month rally in tax-exempt Illinois bonds. The extra yield investors demanded on general obligations due in 10 years instead of AAA munis fell to 1.58 percentage points on Dec. 11, the lowest since August.
In yesterdays sale, the yield spread on the taxable bonds due in December 2038 compared with a gap of 2.6 percentage points above Treasuries on 25-year debt from the April deal.
The taxable bonds were issued via competitive sale, with a unit of Bank of America Corp. winning the bid, Bloomberg data show. The Charlotte, North Carolina-based company also bought the taxable general obligations in April, the data show.
Zia Ahmed, a spokesman at Bank of America, declined to comment on the result of the sale.
S&P was the only rating company to alter its outlook on the state following the pension bills passage, and said the rating could move higher or lower depending on the laws implementation. The company cited the risk that the changes could be declared unconstitutional or invalid, or be delayed.
Before last week, legislators had failed five times since August 2012 to pass a pension solution, pushing Illinoiss yield penalty to the highest among 17 states tracked by Bloomberg. In comparison, bonds of states with top ratings, such as Georgia and Maryland, trade even with or below benchmark munis. Californias premium is about one-fifth of Illinoiss.
While it comes as good news that the state of Illinois is not paying as big of a penalty for its financial instability, Illinois is still paying more than it should to borrow when compared to other more stable and better-rated states, said Laurence Msall, president of the Civic Federation, a Chicago- based nonprofit research organization that specializes in government finance.
Illinois was among five states where retirement-funding ratios fell at least 21 percentage points from 2007 to 2012, data compiled by Bloomberg show. The fifth-most-populous states funding level fell to 40.4 cents on the dollar, from almost 63 cents in 2007, Bloomberg data show. Its retirement systems face $100 billion in unfunded liabilities.
The risk is the market may overshoot credit improvement, and thats a pattern weve seen with other state G.O.s, said Eric Friedland, head of municipal credit research in New York at Schroder Investment Management North America, which oversees about $4 billion in local debt. Over the next couple of months, there could still be some volatility.
Governor Pat Quinn, a Democrat, said in a statement last week that the pension measure is very helpful in our discussions with the rating agencies and the bond buyers who purchase the issuances of the state.
The municipal market is wrapping up almost $13 billion of long-term debt sales this week, the most in three years, Bloomberg data show. The volume pushed yields to a three-month high.
Benchmark 10-year munis yield 2.99 percent, close to the highest since mid-September, compared with 2.88 percent on similar-maturity Treasuries.
The ratio of the interest rates, a gauge of relative value, is about 104 percent, compared with a five-year average of 102 percent. The higher the figure, the cheaper munis are compared with federal securities.
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